ARBITRAGE

The Forex Market

Presented By Gaurav, Harshad, Hemant, Jayashree, Kamalakannan

Todays Objective
To know What is Arbitrage?

To Define Arbitrage
To Know the Features of Arbitrage

To Know the Types of Arbitrage

To describe Arbitrage Between Banks & Two Point Arbitrage in the Forex Market.

Examples & Opportunities

Conclusion

What is Arbitrage
An arbitrage is risk-free in common use, for eg. If we get an opportunity to buy an asset for 5$ from one place and turn around to sell it for 20$ in another place and make 15$ for the effort I have taken which we can call us arbitrage. The 15$ gain would be my arbitrage profit.

Define Arbitrage
An Arbitrage operation can be defined to be the attempt to realize a profit by taking advantage of different prices of currencies in the market. Repeated operations of this kind will cause the differences in the rate to disappear.

Conditions For Arbitrage

The same asset does not trade at the same price on all markets. Two assets with identical cash flows do not trade at the same price. An asset with a known price in the future does not today trade at its future price discounted at the risk-free interest rate

Arbitrage & Its Types

ARBITRAGE BETWEEN BANKS

TWO POINT ARBITRAGE

CROSS RATE & TRIANGULAR ARBITRAGE

Arbitrage Between Banks

Though one hears the term market rate, it is not true that all banks will have identical quotes for a given pair of currencies at a given point of time. The rates will be close to each other but it may be possible for a corporate customer to save some money by shopping around.

Arbitrage Between Banks

Bank A / $ : 1.4550 / 1.4560 B A Bank B / $ : 1.4538 / 1.4548

1.4550

1.4560

A Bank A

1.4538

1.4548

Bank B

Sum Up: Here 1 Pound can be Bought / Sold @ the highlighted $ price in Bank A & Bank B The above situation gives rise to an Arbitrage opportunity, by buying pounds from Bank B @ USD 1.4548 and Sold to Bank A @ USD 1.4550 for a net profit of USD 0.0002 With the latest technology these arbitrage opportunities will be quickly exploited. To seal this opportunity the Bank B should raise the Ask rate and / or Bank A have to lower its Bid rate

Arbitrage Between Banks

Bank A / $ : 1.4550 / 1.4560 B A Bank B / $ : 1.4545 / 1.4555

1.4550

1.4560

A Bank A

1.4545

1.4555

Bank B

Sum Up: Here there is no Arbitrage Opportunity as seen in our previous option. To create an opportunity we should have the ask rate in one quote should be as high as bid rate in the other. Now the Bank A will be hit often on the bid side than Bank B

Two Point Arbitrage

The arbitrage transaction that involve buying a currency in one market and selling it at a higher price in another market is called Two point Arbitrage. Foreign exchange markets quickly eliminate two point arbitrage opportunities if and when they arise.

Calculation - Steps

Determine the Arbitrage Opportunity.

Get the exchange rate for each Pair.

Calculate the Arbitrage.

Two Point Arbitrage

Consider the following spot quotations
Sydney Bank quotes: USD/AUD 1.8885/1.8890 Bank in New York quotes: AUD/USD 0.5275/0.5280 1USD = AUD 1.8890 SYDNEY BANK AUD 1 = $ 0.5280 NEW YORK BANK

Sum Up: AUD is bought for 10k USD value from Sydney Bank and sold to New York bank for the ask rate of AUD 0.5280, that implies 18890*0.5280 Arbitrage Loss : USD 26

Two Point Arbitrage

Consider the following spot quotations
Sydney Bank quotes: USD/AUD 1.8885/1.8890 Bank in New York quotes: AUD/USD 0.5275/0.5280 1AUD = USD 0.5293 SYDNEY BANK USD 1 = AUD 1.8939 NEW YORK BANK

Sum Up: USD is bought for 10k AUD value from Sydney Bank and sold to New York bank for the ask rate of USD 0.5280, that implies 5293*1.8939 Arbitrage Profit: AUD 24

Two Point Arbitrage

Consider the following spot quotations
Sydney Bank quotes: USD/AUD 1.8885/1.8890 Bank in New York quotes: AUD/USD 0.5275/0.5280 1AUD = USD 0.5293 SYDNEY BANK 1 USD = AUD 1.8939 NEW YORK BANK

Sum Up: AUD is bought for 10k USD value from NEW York Bank and sold to Sydney bank for the ask rate of USD 0.5293, that implies 18939*0.5293 Arbitrage Profit : USD 24

Two Point Arbitrage

Consider the following spot quotations
Sydney Bank quotes: USD/AUD 1.8885/1.8890 Bank in New York quotes: AUD/USD 0.5275/0.5280 1AUD = USD 1.8890 SYDNEY BANK USD 1 = AUD 1.8957 NEW YORK BANK

Sum Up: AUD is bought for 10k New York Bank and sold to Sydney bank for the ask rate of USD 1.8890, that implies 5275*1.8890 Arbitrage Loss: AUD 26

Two Point Arbitrage

Consider the following spot quotations
Australian Bank quotes: USD/AUD 1.8885/1.8890 Bank in New York quotes: AUD/USD 0.5275/0.5280 1USD = AUD 1.8885 SYDNEY BANK AUD 1 = $ 0.5275 NEW YORK BANK

Give USD 10560

Take AUD 20000

Give AUD 20000 Arbitrage Profit: USD 27

Take USD 10587

Two Point Arbitrage

Consider the following spot quotations
Zurich Bank quotes: USD/CHF 1.4955/1.4962 Bank in New York quotes: CHF/USD 0.6695/0.6699 1CHF = USD 0.6686 ZURICH BANK USD 1 = $ 1.4936 NEW YORK BANK

Take $669500

Give CHF 1 Million

Take USD 668672

Give USD 668672 Arbitrage Profit: USD 800

Conclusion
Arbitrage is a fascinating process. The execution of an arbitrage trade today is fairly simple through technology. However, as derivatives get more complicated, the procedures employed for doing arbitrage will steadily get more complex. We have to rely on Computers and the speed and efficiency of the operator